Both the sites are under htdocs. i.e. they are a subset of your default server -

lets just say you went to the IP address of the default host... what would be served would be htdocs

lets say you typed in IPaddress/site1you would be served the contents of site1(as it is below htdocs)

ditto site2

If you plan to use .htaccess to secure things/do re-writes etc, don't nest sites, it will complicate your life.

You are welcome to test my hypothesis, I have pointed this out before in many forums. Its as true on IIS as it is on Apache. (although IIS it would be more unlilkely as it would be self-evident - you might even get a scream in IIS management - hmm I might have to test that)

maybe you wanted it that way

As for why doesn't your browser see site2???

A - is there anything to be served in site2?B. - from a command prompt, try pinging site2's FQDN